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On August 29, 2022, in Albert v. Oshkosh Corporation, the Seventh Circuit Court of Appeals affirmed the dismissal of an ERSIA fee-related prudence claim against fiduciaries of Oshkosh’s defined contribution plan. The case is especially interesting because it was a Seventh Circuit decision in the Northwestern ERSIA fee-related prudence litigation that the Supreme Court vacated and remanded in January 2022. The Supreme Court’s opinion in that case represented its most extensive discussion of the standards to be applied to motions to dismiss in these sorts of cases. In Oshkosh, the Seventh Circuit gives its first interpretation of the extent, and limits, of the Supreme Court’s decision in Northwestern.
In this article, we focus on the court’s decision and supporting legal analysis, and on the key legal issue: in fee-based ERISA prudence claims, what must a plaintiff plead to survive a motion to dismiss?
We are going to start with the bottom line and then provide a more detailed analysis.
Bottom line
A simple comparison of “net fees” (expense ratio minus revenue sharing) is not, without more, adequate to state a claim. The Seventh Circuit rejected plaintiff’s (novel) theory that sticker price (i.e., expense ratio) minus revenue sharing is an appropriate “metric” for comparing fund/share class costs. But the possibility that some other court might begin applying this metric remains a risk for sponsors/sponsor fiduciaries.
The Supreme Court’s decision Northwestern is limited. The Seventh Circuit is prepared to limit the Supreme Court’s decision in Northwestern to the issue of its (now repudiated) “categorical rule” that “the inclusion of low-cost investment options in the plan mitigated concerns that other investment options were imprudent.” Other elements of its ERISA fee-litigation jurisprudence, however, including the fairly high bar it is setting for what constitutes an adequate comparator, remain intact. And (to repeat) the Sixth Circuit seems to be taking a similar approach.
We now turn to a detailed analysis of these issues, beginning with some background.
Background
Albert is typical of fee-based ERISA prudence litigation, in which the plaintiff focuses on the alleged imprudence of recordkeeping and fund fees paid by the plan and, in its initial pleading, claims to show that imprudence by comparing the fees the plan paid to the (allegedly lower) fees paid by other plans.
The lower court granted defendants’ motion to dismiss for failure to state a claim. With respect to recordkeeping fees, it found that plaintiff’s claim “did not plausibly ‘suggest[] that the fee charged by Fidelity [was] excessive in relation to the services provided.’”
It divided plaintiff’s claims with respect to fund fees into two categories: (1) claims based on the fiduciaries’ “preference for different share classes of certain investments” (here plaintiff offered a novel theory that the fiduciaries should have preferred share classes with a higher expense ratio but a lower “net cost,” about which more below) and (2) the (more typical) claim that inclusion of higher-priced actively managed funds was imprudent, when essentially the same sort of investment could be had in a lower fee index fund.
With respect to (1), the lower court held that “Plaintiff’s preference for different share classes of certain investments [over those chosen by the plan fiduciaries] is not enough to state a plausible claim for breach of fiduciary duty.” And with respect to (2) that “[t]he fact that the Plan offered certain actively managed options does not establish that Defendants acted imprudently.”
On appeal, the Seventh Circuit reviewed these holdings by the lower court “de novo” (that is, without deference to the lower court’s decision).
Recordkeeping fee claim
Plaintiff argued that the Oshkosh plan fiduciaries violated ERISA’s prudence requirement with respect to the recordkeeping fees paid by the plan by “fail[ing] to regularly solicit quotes and/or competitive bids.” As is typical in these cases, in support of this argument, and to show that the Oshkosh plan’s recordkeeping fees were imprudently high,the plaintiff compared publicly available data for the Oshkosh’s plan’s recordkeeping fees with the fees paid by nine other “comparator plans” with similar participant counts and similar total assets. On this basis, plaintiff alleged that “[b]etween 2014 and 2018, the comparator plans paid an average annual recordkeeping fee of $32 to $45 per plan participant. By contrast, during the same period, the Oshkosh Plan paid an average annual recordkeeping fee of $87 per participant.”
On appeal, the Seventh Circuit upheld the lower court’s decision dismissing this claim. In support of this holding, the court cited its decision in Northwestern, in which it “rejected the notion that a failure to regularly solicit quotes or competitive bids from service providers breaches the duty of prudence.” In this regard, the court quoted Northwestern’s “holding that defendant ‘was not required to search for a recordkeeper willing to take $35 per year per participant as plaintiffs would have liked.’”
In response to plaintiff’s argument that the Seventh Circuit’s holdings Northwestern were “under a cloud of suspicion” after the Supreme Court vacated and remanded it, court stated:
Albert overstates the significance of [the Supreme Court decision in Northwestern] on this point. [That decision] did not hold that fiduciaries are required to regularly solicit bids from service providers. Nor did it suggest that the [Seventh Circuit’s] reasoning in Hecker and Loomis [Seventh Circuit decisions the court had relied on in Northwestern] no longer stands. [The Supreme Court decision in Northwestern] merely rejected this court’s assumption that the availability of a mix of high‐cost and low‐cost investment options in a plan insulated fiduciaries from liability.
In further support of its holding, the Seventh Circuit cited the Sixth Circuit’s recent decisions in Smith v. CommonSpirit and Forman v. TriHealth. In Smith, the Sixth Circuit “held that an ERISA plaintiff failed to state a duty of prudence claim where the complaint ‘failed to allege that the [recordkeeping] fees were excessive relative to the services rendered.’” And in Forman, it held that “plaintiffs failed to state a claim as to ‘overall plan fees’ where ‘the employees never alleged that these fees were high in relation to the services that the plan provided.’”
The fund fees claim
As noted, plaintiff advanced two different theories about why (different) funds selected by the plan’s fiduciaries were (in effect) imprudently overpriced.
First, plaintiff advanced a theory with respect to its claim that the Oshkosh plan overpaid for fund management: Even though the expense ratio on the share classes selected was lower than the comparator share classes proposed by plaintiff, after revenue sharing was accounted for, the “net fee” paid by the plan would have been lower if the comparator share class had been used. Thus, if the alternative comparator funds had been selected, “the Plan’s Participants would have … received virtually identical portfolio management services at a lower cost.”
The court found this theory to be novel – no other court has adopted this sort of “net investment expense to retirement plans theory,” and “[w]hile a prudent fiduciary might consider such a metric, no court has said that ERISA requires a fiduciary to choose investment options on this basis.” Moreover, the plaintiff had not made sufficient allegations about who – e.g., the recordkeeper vs. plan participants – got the revenue sharing, and thus plaintiff had not justified an assumption that the comparator “net fee” arrangement would have benefited participants: “simply subtracting revenue sharing from the investment‐management expense ratio does not equal the net fee that plan participants actually pay for investment management.”
Second, the court rejected plaintiff’s claim that the use of actively managed funds carried too high a price, again citing the Sixth Circuit’s holding in Smith v. CommonSpirit “that an ERISA plaintiff failed to state a duty of prudence claim where the plan merely ‘offer[ed] actively managed funds in its mix of investment options.’”
For these reasons, the court rejected plaintiff’s fund/fee claims.
A Catch-22?
With respect to the Albert plaintiff’s “net investment expense” theory,” it’s worth noting that, as the Seventh Circuit observed, this theory of liability “is the inverse of what ERISA plaintiffs typically argue – that a plan should have offered cheaper institutional share classes instead of more expensive retail share classes.”
And some courts have held that the effect of revenue sharing as a defense to a fee/prudence claim cannot be raised on a motion to dismiss.
If (some other) courts were willing to buy the “net investment expense” theory advanced by the Albert plaintiff, then sponsors would be in something of a bind: On the one hand, if sponsor fiduciaries use a share class with a higher expense ratio but a better net-of-revenue sharing deal, they might be sued for choosing the class with the higher sticker price. On the other hand, if they use the lower expense ratio share class they might be sued for not taking the better net-of-revenue sharing deal.
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We will continue to follow these issues.